financial transaction tax the european approach

FINANCIAL TRANSACTION TAX

– The European Approach

Dorothea Schäfer

1 Starting Points

2 Some Empirical Facts

3 Tax Burden

4 FTT and Financial Market Stability

5 Some Revenue Scenarios

6 Con of FTT

7 Summary and Conclusion

Overview

Dorothea Schäfer 2 Financial Transaction Tax

Dorothea Schäfer Financial Transaction Tax

Starting Points

1

3

Starting Points

Efficient Market Principle is dead

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Financial Transaction Tax Dorothea Schäfer 4

Current crisis speaks clearly against the paradigm of

efficient price formation in highly liquid financial markets.

If markets do not work efficiently anyway, one can hardly

claim that financial transaction taxes would destroy

efficient pricing.

Starting Points

Stability in the financial markets is a public (club)

good

1

Dorothea Schäfer 5

No exclusion, no rivalry in consumption

Financial markets driven by self-interested parties tend to

overuse financial stability and are unable to provide

stability by themselves. Only the state can provide financial

stability. Trading can be interpreted as using the public

good “financial markets’ stability”. Against this background

FTT is a mean to prevent over-usage and to contribute to

the financing of the public good.

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Jan. 00 Mai. 01 Sep. 02 Feb. 04 Jun. 05 Nov. 06 Mrz. 08

Composite-20 SPCS20R

Financial Transaction Tax

Some Empirical Facts

Decoupling of Real and Financial Economy

Foreign Exchange Transactions have increased more than GDP

(Trade Volume) despite the financial and sovereign debt crisis.

2



Explosion of Outstanding Value of OTC

2



Growth Rate way beyond …….

2


Tax Burden

Tax rate and revenue estimation of EU commission

(2011)

3


Tax Rate

Product 0,001 x 2 0,0001 x 2

Securities (Total Amount of Transactions)

19,4

Equity shares 6,8

Bonds 12,6

Derivatives (Total Notional Amount) 37,7

Derivatives based on equity shares 3,3

Derivatives based on interest rate products

29,6

Derivatives based on foreign currency transactions

4,8

In total 57.1 billion Euro

Transaction Volume 2010

Tax Burden

Nominal value - derivatives

Example: Call option

Maturity 3 months, exercise price 100 € (right to buy for 100

euros), the option value at the time of purchase: 8 euros,

market price of the underlying: 80 €. Option is exercised, if

share costs more than 100 Euros.

Taxation based on market price of the underlying, tax

burden per right to purchase one share: 0.0001 x 2 x 80 =

1.6 cents.

Example: credit insurance (credit default swaps)

Tax base: the amount of the insured loan amount


Tax Burden

Tax Burden is high if, and only if, trade activity is

high

3


Simple example:

Let us assume a portfolio of 12 equity securities at a price of 100€ per

asset.

Fairly passive manager: trades 25 per cent of the portfolio once a year

Active management: sells the complete portfolio and buys a new one

twice a year.

Active manager shows an eight-fold higher trading activity.

Tax burden caused by the passive manager: FTT 0.6 Euro = 300€ x

0.001 x 2

Active manager: FTT 4.8 Euro = 2400 Euro x 0.001 x 2

Tax Burden and growth

Estimate of the EU Commission in introducing the FTT in the

EU27 countries

Gross domestic product in 2050:

81.1 percent above the current level compared to

about 81.4 percent in case of non-introduction

However, this minor growth loss arises under the assumption that tax

revenue will be paid back to households as a lump sum transfer.

However, assuming that the public sector invests the tax revenue

productively, the European Commission (EU Commission 2012) expects

positive effects in the amount of 0.2 percent to 0.4 percent of gross

domestic product.


FTT and Financial Market Stability

FTT helps to avoid detrimental activities

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A cascade of new products derived from standard financial instruments multiplies trading activities.

FTT: each step of the cascade would be subject to the tax and also the

subsequent trade of the new instruments. The more derivatives financial institutions construct and trade the higher would be the tax burden in the system.

curbs new product generation reduces turnover frequency makes quid-pro-quo transaction less attractive and curbs

interdependency of financial institutions

Quid-pro-quo transactions (closing)

Bank A: Credit insurance of bank B over 1 million euros for a

premium of 6%.

A-bank does not need the credit insurance anymore:

Bank C: Bank A sells a credit insurance over 1 million euros

at a mininum premium of 6%, with a maturity equal to the

residual maturity of the A-B-bank contract.

Offsetting cash flows cancel out for Bank A.

Consequence: Bank A is not only connected to bank B but

also to bank C.



FTT helps to avoid detrimental activities

4


Speculation with derivatives like naked short selling and credit default swaps

(selling of a security that the trader does not have) also tends to grow

explosively as the cost of entry into the market is very low for a large financial

institute. In times of crisis the European stock exchange supervisory ESMA is

allowed to temporarily ban naked short selling and trade in naked credit

default swaps.

But an FTT would permanently decrease the attractiveness of market entry

with such instruments and thus dampen the overall activity of financial

institutions in this segment.


FTT helps to avoid detrimental activities, cont.

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Financial Transaction Tax ? Dorothea Schäfer 16

A dampening effect of the FTT can be also expected in financial

transactions that are made solely for regulatory reasons:

• Financial institutions with large balance sheet amounts but a too low capital

basis may use REPOS for window dressing.

FTT makes such cosmetic transactions less attractive.

• FI outsource often assets into the shadow banking system (SPV or hedge

fund). Outsourcing turns previously internal transactions into trading

between independent units.

FTT would punish outsourcing and reward internalizing transactions. This

effect would contribute to combat the shadow banking system.

COUNCIL DIRECTIVE

implementing enhanced cooperation (11 members)

• The tax is levied

• if a party to the contract is based in the taxation zone (country of

origin principle)

• the financial instrument is issued by a financial institution in

the taxation zone

• if trade takes place within the taxation zone.

Principles of taxation: combination of country of

origin, issue and trading location

5


Revenue Estimate for 11 countries 5

Finanztransaktionssteuer Dorothea Schäfer 18

in billion Euro

Distribution of tax revenue according to

BIP (EU Commission 2013)

Profits + Salaries (DIW 2012)

Assets of credit institutions (DIW 2012)

1 Belgium 1,7 1,6 1,6

2 Germany 11,7 9,9 11,2

3 Estonia 0,1 0,1 0,0

4 Greece 0,9 1,1 0,7

5 Spain 4,8 4,2 4,9

6 France 9 7,1 10,8

7 Italy 7,1 6,2 5,3

8 Austria 1,4 1,3 1,6

9 Portugal 0,8 0,9 0,7

10 Slowenia 0,2 0,2 0,08

11 Slovakia 0,3 0,3 0,08

Total 11 38 32,7 37,6

12 Danmark 1,09 1,03 1,64

13 Cyprus 0,08 0,06 0,20

Total 13 39,12 33,8 39,4

Main Con of FTT

Pure hedging activities are not identifyable

Hedging for the real economy is subject to taxation

Real economy „will be punished“ for seeking security

against excessive price fluctuations

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Financial transaction tax Dorothea Schäfer 19

Volatility Example: Copper 6


Volatilität Copper

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0

100

200

300

400

500

600

2008 2009 2010 2011 2012

Max daily price deviation (in €)

Average dailyprice deviation(in %)

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

16,0%

18,0%

2008 2009 2010 2011 2012

Max daily pricedeviation (in %)

Average daily pricedeviation (in %)

However, presumably, only a small part of the

complete trade volume is caused by pure hedging

Handelsvolumen und Produktion 6


Source: Annual report 2011 of the German association „Wirtschaftsvereinigung Metalle Trade volume: production volume multiplied by 33, multiplied by 20 and multiplied by 50. Pure Hedging?

LME-trade volume: share of the world production of several metals

World production

Trade Volume

Aluminum Copper Zinc

Con of FTT

What to do?

Exemptions?

Should derivatives based on commodities exempt from being taxed?

Likely outcome: Arbitrage between financial instruments

Better alternative: refunding

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Summary and Conclusion

FTT is important for stopping the decoupling of financial

markets from the real economy.

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• Self-interested parties tend to overuse the public good

financial stability.

• Need of new tools that promise improvement in the crisis

and complement the regulatory steps

FTT increases transaction costs and offers the prospect of

slowing down the mutually reinforcing trend of more and

more derivative products and shorter holding periods.

Vielen Dank für Ihre Aufmerksamkeit.

DIW Berlin — Deutsches Institut

für Wirtschaftsforschung e.V.

Mohrenstraße 58, 10117 Berlin

www.diw.de

Thank you very much for your attention

financial transaction tax the european approach

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